Citigroup’s Unusual Problem: How to Incur More Taxes

American Money

Citigroup (NYSE:C) is struggling with an unusual problem: how to to incur more domestic taxes. That goal may seem counterintuitive coming in an era in which many American companies are trying to keep much of their foreign income abroad to avoid paying higher U.S. taxes on the profits. The bank is not feeling generous, rather it has to make use of the $55 billion in tax credits and deductions, known as deferred tax assets, that it had accumulated as of March.

Realizing these benefits over time could be worth about $27 billion, or close to $9 per share for the company’s stock, which trades at around $50 per share, Sanford C. Bernstein analyst John McDonald told Reuters. Using the assets will free up more than $40 billion, or about one-third, of the bank’s capital.

A source told the publication that Citigroup attempted to buy the foundering Wachovia in the fall of 2008 with the hopes that the acquisition would bring it more taxable domestic income. In February of this year, the bank bought a portfolio of approximately $7 billion in Best Buy credit card loans from Capital One Financial (NYSE:COF), a move that Chief Executive Michael Corbat said in March said was related to the company’s tax position. Citigroup has even reclassified foreign profit as money that it might bring back to the United States.

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The deferred tax assets were accumulated from losses and foreign tax payments that came during and after the financial crisis. While Citigroup has been utilizing the assets in recent years, it has been creating new ones simultaneously through expenses like mortgage litigation settlements. In fact, in 2012, the bank’s deferred tax assets actually grew by about $3.8 billion. But, Corbat said at Citigroup’s annual meeting in April that turning that trend around was one of his top priorities.

U.S. companies acquire deferred tax credits because they are required to keep two sets of books — one for the financial markets and one for the Internal Revenue Service — and items, like costs from expected losses on loans, are recorded at different times on the two books. A cost that is recorded on a bank’s financial market book, but is not recognized for tax purposes until later, generates a deferred tax asset. Regulators make banks to use more capital to support those assets because there is often uncertainty regarding whether the assets will be fully realized.

For Citibank, converting the tax benefits into cash is not an easy task. The bank has estimated that it must earn as much as $112 billion in taxable domestic income in order to use all of its deferred tax assets, and buying U.S. assets would be one way to achieve that goal. Like any company, Citigroup must find deals that make economic and strategic sense, but within that framework, it also must look for transactions that will use its deferred tax assets. Already, doubts over the bank’s ability to realize its deferred tax assets are baked into its share price.

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As a source told Reuters, Citigroup’s two most important source of taxable domestic income are the investment banking business, in particular corporate bond underwriting and trading, and the credit card business. Therefore, the recent sell-off in bonds could help boost bond trading revenue, and as a result taxable U.S. income, because market shifts typically spur more trading volume. If the U.S. economy continues to recover, the bank’s credit card revenue will also grow, and the improving housing market will help Citigroup use or reverse deferred tax assets linked to mortgages.

“We’re no longer in the throes of an economic crisis, and it would be shocking to me if they wrote them down at this stage,” former Lehman Brothers accounting analyst told the publication.

Bank of America (NYSE:BAC), which has larger U.S. operations than Citigroup, has just $33 billion in deferred tax assets.

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